As a small business owner, debt can make or break a business’ ability to grow at a sustainable rate and remain well capitalized. To better understand your current debt, you should review the terms of your existing loans by reading your loan agreements. But when does it make sense to refinance your current business debt and plug it into your long-term growth strategy?
Here are at the first six questions you should ask yourself when making this determination:
1. Does refinancing your current debt generate a minimum 10% monthly savings over your current payment?
Any refinancing of commercial debt should yield a monthly tangible cash savings of 10% or more. When new debt creates this type of cash savings, it also means that the new debt likely has a lower interest rate and/or longer repayment term than the existing debt. Lower rates and longer terms are good for cash flow and expansion.
2. Does your Commercial Real Estate Loan have a balloon payment?
Most conventional lenders structure commercial loans with maturities of 5 to 10 years, even though the payments are amortized past the maturity date (often 15 to 25 years). This type of loan structure creates a balloon payment due at the end of the loan term, forcing Borrowers to come up with a lump sum payment at the end of a 5-to-10 year loan term. Eliminating a balloon payment when you refinance your debt means your new loan is fully amortizing and you will not have a large cash payment due at the end of your loan term. This is important so that you can focus on running your business and not worrying about extending or refinancing your loan every 5-to-10 years.
3. Do you have existing short-term or Credit Card Debt?
Who wants to keep paying interest rates of 18% or higher when a new commercial loan has a rate that is less than half that? Consolidating short-term and credit card debt into a term loan will save your business cash that can be used to pay down the outstanding balance.
4. Do you have a revolving Line of Credit that’s nearly maxed out?
If you have not paid down a business line of credit or your Bank says it cannot be renewed or extended, it may be time to refinance into a term loan. This happens often, especially in times of recession, when sales may drop off, receivables may be slow to come in, or inventory isn’t turning as fast as you need it to. In fact, sometimes short-term working capital needs become long-term working capital needs. Terming out your RLOC can get you back on the path of clearing debt off your balance sheet while getting on an affordable amortization schedule.
5. Is the term of your existing loan used to finance a specific business asset, such as real estate or equipment, shorter than the remaining economic life of that business asset?
We have seen loans where a borrower purchases a piece of equipment that has a useful life of 7 to 10 years (or longer), but the loan used to finance that purchase is amortized over 3 years. This type of loan does not match the debt repayment schedule with the useful life of the asset, making such a short-term repayment unreasonable. Why would you want to pay for a piece of equipment over three years when you expect it to help you generate revenue for 7 to 10 years? That same case can be made for Commercial Real Estate, such as an office building or a Hotel. Why would you want a commercial real estate loan with a term of 10 years when most commercial real estate assets have a remaining economic life of at least 25 years or more? You should be sure your debt has terms that are reasonable for the assets the debt is securing.
6. Have you determined that the terms of your current business loan no longer meet the needs of your business?
Businesses grow and expand all the time and knowing how to properly leverage your assets can provide additional capital to meet new goals and reach new heights. You may be carrying debt that was borrowed years before for purposes that no longer exist. Unless you refinance these loans with terms that meet your current needs, you will not be able to accomplish new goals. Any existing debt that prevents you from meeting new goals would be deemed on unreasonable terms.
If you have answered YES to any of the above questions, then you may qualify for an SBA or USDA guaranteed loan that can provide the capital necessary for your business to grow and thrive. Get in touch with one of our specialist.